The air around Housing Finance stocks seems to have vanished. A story that was being sold in the name of Housing for all and X Million housing units required in the next decade is now not heard anywhere. Many investors are confused as to why, despite high AUM growth, is the share price falling.
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| Last price as of 14th June 2018 close |
As a disclaimer - DalalStreetBulls had recommended Dewan Housing in 2014-15 and increased allocation in 2017 in Dewan Housing. The stock has fallen the least (apart from HDFC). We have now reduced exposure for the first time in Dewan Housing on 13 June, 2018 to a maximum of 10% of portfolio for old investors and 4% for new investors.
Industry Trend
Mortgage penetration in India has increased from ~ 7% in FY07 to ~ 9.6% in FY17. The penetration is expected to increase to ~ 12% to 14% by FY23. The share of HFC's in the home loans segment has grown rapidly from 31% in FY10 to 41% in FY18. PSU Banks have lost the major share amidst the NPA mess of the last few years. The demand for housing finance has grown at a healthy CAGR of 18% over the last 7 years and in this period HFC's have grown their home loan books at ~ 23% p.a. The home loan rates for HFCs and Banks is slowly converging as Housing Finance companies are able to reduce their cost of borrowing (majorly through capital market instruments).
With the recapitalization of PSU Banks, will they emerge as tough competitors for HFC's and try to recoup lost grounds? Further, with the entry of many players in the HFC space (Motilal Oswal, Muthoot, etc) HFC's might resort to lending to riskier segments and will face pressure in raising the interest rates. In a scenario where interest rates are rising, HFC's will have to increase their rate of lending. Further, as interest rates rise, investors might be deterred to invest in real-estate.
Company Analysis
Housing Finance companies can be segregated into different categories based on whom they lend to, the ticket size, geographical concentration, etc.
i) Who lends to whom?
ii) Ticket Size
AS you can see, GRUH has a niche in lending to the low ticket size group. This segment primarily resides in the rural areas and GRUH faces little competition in this segment. There is heavy competition in the 20 Lakhs to 26 Lakhs segment and HDFC, LIC Housing Finance enjoy a strong leadership in this segment. The recapitalization of PSU Banks is expected to impact this segment the most in terms of competition and ability to increase interest rates.
iii) Home loan as a % of total AUM
To boost up earnings and AUM growth, many HFC's are now venturing into higher yield products such as construction finance and loan against property. These products have a higher NPA rate and carry a higher risk than a simple home loan. Further, the ticket sizes of these loans are big (ranging from Rs 1 Crore to Rs 500 Crores). Dewan Housing's share of home loans in total AUM has fallen sharply over the last 3 years. PNB Housing Finance has the lowest share of home loans in the total AUM at just 56%. Repco, Can Fin, LIC Housing and Gruh have a share of more than 80% of AUM in Home loans.
iv) Gross NPA
- Gruh lends primarily to the rural regions and low ticket size borrowers. 50% of it's borrowers are not salaried employees, however the company has maintained a good asset quality and has one of the lowest NPA rates in the industry
- Repco and PNB Housing Finance cater to a similar segment (self-employed) and Repco has a higher share of home loans in the AUM but it's NPA rate is much higher than PNB Housing's. Repco has a big exposure to the Tamil Nadu market ( > 60% of loan book ) but the management is pushing to create a geographical diversification.
- LIC Housing Finance majorly caters to the Salaried employees and has a gross NPA of 0.78%. The company is focused on home loans which make up ~ 80% of it's AUM
The Housing Finance sector is seeing a sharp rise in NPA's as the companies look to encash on the push towards Housing for all. This can hurt the Return On Equity of most HFC's. Asset quality has to remain stable if the high PB Ratio of most HFC's is to be justified.
v) AUM Growth
The AUM Growth for most companies is on the back of high growth rates in loan against properties and construction finance. The home loan growth rates are lower than the overall AUM Growth rates. While the investing community has been focusing on AUM Growth rates till now, the focus will have to shift to the Return on Equity, NPA numbers eventually. The home loan growth rate for most HFCs remains in the low-teens. There are several issues on the supply side as real estate companies face problems in selling existing inventory, post-Demonetization, GST and RERA transition, acquisition of new land. Only when supply issues are solved, the home loan book can meet the high growth expectations of the street.
vi) Cost to Income
HDFC and LIC demonstrate their efficiency by operating at low cost-to-income ratios. Dewan Housing's management has successfully lowered the cost to income ratio and have given a further guidance of lowering the ratio by 200 bps. GRUH does a tidy job of maintaining a low cost to income ratio despite operating in small population geographies.
vii) Cost of Funds and NIM
The HFC which can control the borrowing cost in a rising interest rate scenario stands to benefit the most. LIC Housing Finance has seen a sharp decline in spreads in FY18 and coupled with a slow growth in home loan book, the company's low PAT growth has sent the stock price plummeting.
Investors need to look at the Asset-Liability mismatch for a better judgement of impact of rise in interest rates.
viii) Valuations
GRUH commands the highest PB Ration - Much higher than the industry average. The market expects GRUH's niche dominance to continue without any major competition from other HFC's and GRUH's management has also shown their ability to grow AUM with stable asset quality. PNB Housing Finance commands a premium valuation based on high expectations in the AUM Growth. A rising interest scenario can put pressure on both NIM and ROA (Return on Asset).
We believe that AUM Growth should not be the metric to value a Housing Finance company as a deterioration in asset quality can hit the profitability and the return on equity.
PNB Housing is the most expensive HFC as it offers a low Return on Equity and commands a high Price to Book ratio. If PNB Housing is unable to improve it's ROE to 18% to 20%, then the stock could see a re-rating in the PB Ratio to the lower side. Gruh is expensive and the market has factored in all the positives in the company, it offers no valuation comfort. The stocks that appear to be the cheapest are: IndiaBulls Housing and Dewan Housing. There is a big room for re-rating in Dewan Housing, provided that the management is able to improve asset quality, improve opex to income ratio and maintain a healthy mix of home loans and other loans.
Our View:
Many housing finance companies will see:
i) A spike in NPAs due to rise in share of riskier loans such as LAP, construction finance
ii) Pressure on spreads due to rising interest rates and increasing competition from other HFCs and Public sector banks
iii) Lower ROEs and a re-rating of the Price to Book ratios
Which housing finance stock should investors buy?
- There will be immense competition in the home loan segment and spreads will be below the 2014-17 period. Housing finance companies that maintain a balance between home loans, loan against properties and construction finance and control the asset quality will enjoy higher spreads over their peers.
- Companies with the highest credit rating will be able to keep borrowing costs lower than peers and enjoy higher spreads.
- Companies in a niche segment will face lower competition from peers and public sector banks and thus will be able to keep spreads high. Now, companies catering to the "riskier" segment face asset quality risk and thus one should look for companies which have demonstrated in the past that they can maintain good asset quality.
- AUM Growth will be critical as a low growth rate in a period when other HFC's are growing faster will mean a loss of market share.
The above table does a brief comparison of different HFC's on some qualitative factors. PNB Housing appears to have the most green flags and Repco appears to have the most red flags, however the current valuations and the case of re-rating matters the most for a prospective investor.
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